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Commercial vs. Residential Rental Investments

Hello, property and potential property owners! Welcome to the RPM Distinguished Care blog, where we provide practical advice about property management! If you’re a return visitor, welcome back. We sincerely appreciate your support! RPM Distinguished Care specializes in managing successful rental properties in and around the Charleston area. We’re here to make your lives easier by giving you the resources you need to maximize profitability and have a successful rental property. We provide comprehensive property management services at every conceivable level. From advertising and marketing to responding to applications, to inspecting and maintaining properties–there’s nothing we do not do. Further, we ensure tenant compliance, handle necessary evictions, and report directly back to you about revenue and profit potentials. We aim to make owning rental property as easy for you as possible, for as little money as possible. Check out the rest of our site to meet our team and discover what makes RPM Distinguished Care the best property management company in Charleston!

Our last article was a detailed explanation of how to tailor a real estate portfolio according to your long-term goals. We began with how to define your real estate portfolio goals and how to create a targeted strategy, before delving into diversification. Like any portfolio, a real estate portfolio benefits from variety. By investing in different kinds of properties, you can mitigate risk and hedge rental market volatility. We explored the different asset classes and rental property types. Finally, we provided a few metrics by which you can assess the success of your real estate portfolio, along with how to adjust when necessary. How to Create a Real Estate Portfolio is the perfect addition to our recent set of articles about rental property fundamentals: short-term vs. long-term rentals and single-family vs. multi-family rentals and crafting long-term goals for your rental property. Be sure to give those articles a read when you’re done here!

Many rental investors—especially beginners—hesitate to dabble with commercial properties. Like multi-family homes, commercial rental properties can seem like more work than their residential counterparts. Today, we’re breaking down the key differences between commercial and residential rental properties. Is it harder to obtain a rental permit for a commercial property? Do residential and commercial properties share the same occupancy rates here in Charleston? Which type of property is better for beginners? Don’t worry! We’ll answer all of your questions (and a couple more) in this article. By the end, you should have a pretty good idea of whether you’re interested in investing in residential property, commercial property, or both. This puts you one step closer to building the real estate portfolio of your dreams! If you’re interested in learning more, read on!


Residential vs. Commercial Rentals

Residential real estate serves the primary purpose of providing a residence in which individuals and families can reside. While commercial real estate serves the primary purpose of providing a space in which individuals and businesses can conduct activities related to commerce. Commercial properties can also house people and this is where things can become a bit convoluted. Technically, a residential property is either single-family or multi-family. If a residential property is multi-family, then it’ll contain up to four residential units. Anything over four residential units and the property becomes “commercial.” 

If you are building a residential building, there are certain codes and regulations which must be met in order to qualify for a permit of occupancy. Commercial buildings have different codes and regulations—many of which can be complex or expensive. These regulations depend upon the occupancy classification given to the building. For example, if you invested in an office building, this would be classified as Business Group B. Business Group B is for “the use of a building or structure, or a portion thereof, for office, professional or service-type transactions, including storage of records and accounts.” The same classification would apply to a retail space. However, if you invested in a hotel and offered short-term stays (less than thirty days), the building classification would be Residential Group R-1. Yes, residential. This is the building classification, but for tax purposes—which we’ll discuss more in-depth in the next section—the building is considered commercial. If you invested in a hotel and offered long-term stays (more than thirty days), the building classification would be Residential Group R-2.

Building classifications aren’t always solely based upon the intended purpose of the property. The number of occupants likely to occupy the building at any given time also helps determine its classification. For example, buildings classified for assembly are separated into subsets A-1, A-2, A-3, A-4, and A-5. Depending on the number of people predicted to gather in the building, assembly buildings are expected to provide a different number of exits and uphold different safety measures. 


Tax Implications

For tax purposes, whether or not your property is residential or commercial will play a role in determining whether or not your rental activities qualify as an “investment” or a “business.” If your rental activity is considered a business, you can take advantage of certain tax breaks (e.x. Home office deduction, start-up deduction, Section 179 expensing). According to the IRS, a rental business involves working “regularly and continuously.” However, the IRS does not stipulate who needs to be working regularly and continuously. For example, if you hire a property management company to manage your office building and provide you with the profit each month, the IRS will still find your rental activity regular and continuous, since the property management company is acting under your direction. A single-family home can qualify you as a business owner, as can a multi-unit commercial property. 

Now, a commercial property tax is most likely going to be steeper than a residential property tax. As well, there are several kinds of property taxes for commercial property. For example: property, federal, state, or local, and rental or sales tax. Your commercial property tax rate depends on the assessed value of your property. The effective property tax rate for commercial property in South Carolina is 0.52%, as of 2019, which is almost a full percentage point below the national average. Then there are federal taxes, which are determined by the net income you receive from your commercial property (not including security deposits). State and local taxes are determined by your location. This includes municipal fees, education tax, transportation tax, local option sales tax, state sales tax, corporate income tax, and more. The income tax rate for Charleston is currently 7%, which is over 2.5 percentage points higher than the national average. The City of Charleston has an accommodation tax for short-term rentals and the rate is 2%. 


Which investment is better for beginners? 

Undoubtedly, commercial rental properties offer higher returns (i.e. cash flow). However, they often require a heftier initial investment, too. You can use triple net leases—or leases that include the cost of rent, property taxes, insurance premiums, structural maintenance, and repairs—as these kinds of leases solely benefit commercial investments. With a commercial property, you can offer longer lease terms (i.e three, five, or ten years). This ultimately means less turnover and, thus, less risk. Just make sure you choose the right tenant and establish legal protections. Finally, commercial real estate can accrue value much more quickly than residential property.

That said, residential rental properties are a better option for beginners due to their ease of entry. You can use a smaller initial investment to get started and build wealth at a slower rate. As we mentioned, the zoning laws and regulations for residential properties are much more lenient than for commercial properties. There’s a much larger rental pool for residential properties, as well. Think about it. We all need somewhere to live, but in the digital age, we can work and shop anywhere. For this reason, residential properties perform much better in times of economic crisis. When businesses are closing and commercial property owners are looking for tenants, residential property owners are mostly taken care of. 


We hope this has been an informative lesson! Choosing between commercial and residential rental property is one aspect of cultivating a successful real estate portfolio. Remember to keep your goals in mind and stick to your long-term strategy! At RPM Distinguished Care, we work alongside our clients for however long it takes to reach their unique goals. We levy every asset at our disposal, including over thirty years of experience and a dedicated team of individuals, to be of assistance. From tenant screening to leasing to inspections to marketing–there’s nothing we do not do. We believe in full-service and comprehensive property management. That’s why we take the time to understand each of our clients and help identify their most closely-held goals.  Use our website to request your free assessment and meet with our expert team! Thank you for taking the time to read this article and we hope to hear from you soon!

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